Sale of the century

Over the past year, the Chinese government has put up for sale big stakes in the country's most valuable state companies. They include the two oil giants, Petrochina and Sinopec, one of its two mobile telephone heavyweights, China Unicorn, and the country's largest steel plant, Baoshan.

Initial public offerings (IPOs) and new share placements of Mainland state firms raised a total of US$43bn on Hong Kong's stock market, China's main window for external financing. Another US$17bn was raised from IPOs in the domestic markets of Shanghai and Shenzhen.

Such a massive fund-raising exercise helped China's closed yuan-denominated A-share stock market to be one of the best performing in the world last year, with its stock indices up 50 percent from 1999. An average of two new companies were listed every week in China – similar to New York's Nasdaq market before its recent collapse.

This year, China is going to the markets again for an estimated US$12bn-20bn in Hong Kong and a smaller amount in the US. State companies scheduled for listing include the crown jewels of industrial China: China National Offshore Oil Corporation (the country's third largest oil company), China Telecom (the fixed-line telephone monopoly), China Netcom (a dominant internet operator) and Bank of China (the main foreign exchange bank).

The Chinese government is willing to sell down these previously closely held assets because it needs massive sums of money to pursue its next round of economic reforms.

The first urgent task is the cleaning up of an estimated Yn1,900bn of state bank bad loans. The government has already transferred Yn1,300bn of non-performing loans to four asset management companies (AMCs) but this is only an interim measure. Mr. Qu Hongbin, economist at Bank of China International in Hong Kong, says that the recovery ratio of loans at the AMCs will be at best only 30 percent. The AMCs, relying entirely on the state for capital, do not have the resources to absorb these loans on their own. That means the state will need to have billions of yuan ready before it can write off the bad debts and allow state banks to operate with a stronger balance sheet.

Crumbling social security system
Another reform that requires massive funding is the creation of a new national social security system. The old pay-as-you-go, corporate-based system is crumbling, as debt-ridden state firms can no longer support their aging staff with expensive medical and pension schemes. The problem has become more acute as state firms have delayed pension payments to their retired workers. More such delays are likely in future as there is a funding shortfall of an estimated Yn2,000bn in the state pension system.

The government also needs money to help state firms reduce their debt, pay off their redundant workers and buy new machinery and technology. Again, making state firms more competitive has become urgent as foreign rivals will arrive after China joins the World Trade Organisation, probably later this year.

Qu, of Bank of China, estimates that writing off the bad loans and setting up a functioning social security system would cost the government Yn4,000bn, equivalent to 48 percent of China's GDP in 1999. He says that to fund these reforms, the state has several options: tax increases, public borrowing, printing more money or selling state assets.

There is little scope for raising more taxes from companies. State firms, the biggest contributor to the government's coffers, already have a back-breaking corporate tax rate of an average of 33 percent.

The government is working to increase tax revenue from individuals, particularly by tightening its collection procedures. However, this is a long-term task and officials are wary that an increase in the individual tax burden might damage the economy by dampening the still-sluggish consumption levels.

Issuing treasury bonds is not an attractive option either, says Qu. Already the government has sold a record volume of treasury bills to finance infrastructure projects in the last two years, in a bid to stimulate economic growth. Servicing public debt is getting expensive; last year, 40 percent of the central government's revenues were used to pay off interest and principal of its debt.

Printing more money is also not a viable financing policy, says Qu: "China now has deflation but once the government sets the presses rolling, it will find it difficult to shut them down. The guaranteed consequence – hyperinflation – would be disastrous."

Selling state assets in the stock-market is probably the most cost efficient way to raise a massive volume of funds quickly. Such a sale is also in the spirit of reform, because it should in theory reduce the government's involvement in corporate activity.

The government is certainly rich in assets. Qu says that it owns most of the country's financial services, communications, media outlets and 25 percent of its manufacturing businesses. Of the estimated Yn5,000bn worth of state assets floated on the stock-markets, the government has a stake of 62 percent, worth more than Yn3,000bn at current market prices.

In the past, the government has jealously guarded such assets, fearing that any reduction in the stake would erode its control over the state sector. Eventually, it realised that as long as it remains the single biggest share-holder, it can sell shares without compromising its absolute control. Even if a state firm is listed, the State Council, ministries and other government departments will continue to have the final say in the operation of the state firms they oversee.

With its main anxiety removed, the government has decided to give up some state assets. In the early 1990s, it sold mainly individual steel plants, highways; power plants, electronics makers and other small to medium-sized firms, raising a few hundred million dollars on each occasion.

In the last two years, however, it has become more ambitious, floating big chunks of major state firms, such as China Mobile, the biggest and best-performing Mainland China stock on the Hong Kong market.

The government became more aggressive after the fifth plenum of the 16th Communist Party congress held last October. The meeting reconfirmed the importance of capital markets in China's economic development, a green light to increased privatisation.

Now that the government has overcome major ideological hurdles and is happy to sell more state assets, is the market ready for it? Analysts say much will depend on the sentiment of global investors this year.

Ms. Jeanette Li, an analyst at the HSBC banking group in Hong Kong, says investors' interest in Mainland shares remains high: "Their confidence has been boosted by China's economic rebound and its imminent entry into the World Trade Organisation."

Too big to be ignored
Mr. Fan Chuek Wan, an assistant director at ABN Amro, says that China is too big to be ignored. In Morgan Stanley's global investment benchmark, the weighting of the greater China region (China, Hong Kong and Taiwan) has gone up from less than 1 percent a decade ago to the current 10 percent.

Another broker, however, says many investors have been discouraged by the poor performance of Mainland firms listed earlier. Almost all of them are trading below their IPO prices and have had poor earnings for many years. "These companies are interested only in getting money from shareholders, not in improving their performance," he says.

The market has showed signs that it might be losing interest in Mainland shares. China National Offshore Oil Corporation, the first mega-listing this year in Hong Kong, had a lukewarm reception when it listed in February. This was the second attempt to float by China's third-largest oil company, following the poor reception it received in its first trial in late 1999. This time round, it priced its shares lower, at a price-earnings ratio of 5-6 percent, compared with the double-digit ratios that other international oil companies currently enjoy.

Analysts say there will be buyers of Chinese shares, if they are priced right. "There will always be young, inexperienced fund managers who buy the story that China is a high-growth economy, where investors should place their money," says a Hong Kong-based equity analyst.